Interview Series: WIOF China Performance Fund

How has the Fund performed recently compared to its peers and are there any particular stocks or areas where the Fund is performing well?

We became investment advisors to the fund during May this year and immediately restructured the portfolio to reflect our systematic approach towards stock selection. Given the short time period and the impact of recent restructuring costs, any assessment of relative performance at this stage would be premature. Nonetheless, despite the high levels of Chinese market volatility in recent months, we are encouraged that gross performance has been comfortably ahead of the benchmark since inception.

Much has been said recently of problems in the Chinese economy. Do you think the Chinese economy is in for a ‘hard-landing’ and if so, what strategy have you adopted, or will you adopt, to limit its impact on the Fund?

As systematic investors, we prefer to focus on isolating the most appropriate investment styles for any given market. At present, the portfolio contains no significant sector biases, but is overweight low volatility/high financial strength small-cap stocks. It is therefore interesting to note that, although we do not predict the likelihood of a Chinese ‘hard’ or ‘soft’ landing, we are stylistically hedged for either eventuality via exposure to cyclical small-caps with defensive characteristics.

Europe is a key export destination for China. How badly have the Chinese economy and markets been affected by the problems in Europe and how would they be affected by either a ‘Grexit’ from the Eurozone or a complete break-up of the Eurozone?

The impact of a full blown Eurozone break-up would clearly be negative for Chinese companies, though we believe that the ongoing restructuring of the Chinese economy away from international export led growth towards internal consumption should help to mitigate such risk over the medium to long term. Although Chinese economic growth has begun to slow, we were encouraged to see that almost three quarters of Q12012 GDP growth was driven by domestic consumption.

Beijing implemented stimulus measures at the start of the financial crisis and appears set to do so again now to boost the economy. To what extent will such measures feed through to stock markets and present opportunities for investors?

Though additional stimulus measures by the Chinese authorities are to be welcomed in principle, the nature of this spending must be carefully assessed before we can infer the likely impact for investors. For example, it appears that Beijing is seeking to accelerate infrastructure investment, a quick method of stimulating the economy which would benefit industrial sectors, but could also act to reverse the government’s attempts to rebalance the economy towards consumer-driven growth.

The central bank in June cut interest rates for the first time in four years in a move to try and support the economy. Do you think the move will provide the boost the economy appears to need?

The move certainly came as a surprise, accompanied as it was by liberalization measures that should stimulate borrowing by giving banks the freedom to set deposit rates and offer rates on new loans away from the official policy rates. This is a significant move that should increase returns for households in addition to creating greater competition between banks. We would expect such moves to provide a meaningful economic boost in the short-term, but note that they also increase systemic risk if too much of this money finds its way into inefficient state-owned enterprises and property developers.

China has long benefited from cheaper labour compared to other parts of the world. But with wages now rising in China, is it likely to lose this competitive advantage, and if so, what does this mean for investors?

Wage inflation in China has risen by 15-20 per cent annually for the last couple of years, which has undoubtedly had a negative impact on margins for Chinese companies. However, this does not necessarily mean that the Chinese comparative advantage, even in highly labour intensive industries such as textiles and toys, will be eroded entirely. There is evidence that China’s manufacturers have begun to gain some pricing power and successfully passed on cost inflation to their customers. Moreover, Chinese infrastructure remains superior to those of rival developing economies, which should encourage manufacturers to retain operations on the mainland.

Your investment strategy sees the portfolio underweight in financials but overweight in telecoms and energy. Could you elaborate on this and is this likely to be a long-term strategy or just a reaction to current short-term trends?

The sector weights mentioned are a natural function of our Shariah-compliant investment universe. Our active sector allocations compared to the Shariah universe include a small bias towards Industrials, Utilities and Consumer Discretionary stocks. These sector preferences reflect our current stylistic emphasis on companies offering relatively low share price volatility, high levels of returns on equity and a high dividend yield.

If you had to describe the most attractive characteristics of Chinese equities to an investor, what would you say?

Chinese equities currently offer attractive valuations, even on longer-term 10-year average price to earnings multiples, valuations remain below historical averages. There are clearly risks on the horizon, as the country manages the tricky transition from investment to consumption driven growth at the same time as dealing with demographic challenges and weaker growth in developed economies. However, if, as we believe, these risks are already more than priced in to current equity valuations, then the potential for strong investment returns over the medium term looks compelling.

How do you see the prospects for Chinese markets in the next six months?

Over the next six months we will probably see a continuation of market volatility as global investor sentiment swings between focusing on the problems of the Eurozone and the more positive US outlook. However, with the US economy looking towards recovery and the recent loosening of policy in China we believe that any downswings should be taken advantage of by longer term investors.

IMPORTANT NOTE: This report has been prepared for information only, and it does not represent an offer to purchase or subscribe to shares. World Investment Opportunities Funds (“WIOF”) is registered on the official list of collective investment undertakings pursuant to part I of the Luxembourg law of 17th December 2010 on collective investment undertakings as an open-ended investment company. WIOF believes that the information is correct at the date of production while obtained from carefully selected sources considered to be reliable. No warranty or representation is given to this effect and no liability can be assumed for the correctness or accuracy of the given information which may be subject to change at any time, without notice. Past performance provides neither a guarantee, nor an indication of future performance. Value of the shares and return they generate can fall as well as rise. Currency fluctuations, either up or down, may also affect value of the investment. Due to continuing market volatility and exchange rate fluctuations, the performance may be subject to significant changes over a short-term period. Investors should be aware that shares in the financial instruments entail investment risks, including the possible loss of the invested capital. Performance is usually calculated on the basis of the relevant NAV unless stated otherwise. Performance shown does not take account of any fees and costs associated with subscribing or redeeming shares. It is assumed that all dividends were reinvested. WIOF prospectus is available and may be obtained through www.1cornhill.com. Before investing in any WIOF Sub-fund(s) investors should contact their financial adviser / legal adviser / tax adviser and refer to all relevant documents relating to the WIOF and its particular Sub-fund(s), such as the latest annual report and prospectus that specify the particular risks associated with the Sub-fund, together with any specific restrictions applying, and the basis of dealing. In the event investors choose not to seek advice from a financial adviser / legal adviser / tax adviser, they should consider whether the WIOF is a suitable investment for them.